United State Financial Crisis 2007 - 2008

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The global economy has been developing rapidly and gaining many achievements which have a lot of motivating influences on the wealth of many countries in the recent decades. However, there still remain a number of difficult problems that need proper solutions brought in by the governments. Financial crisis is not out of the case. For many years now, financial crisis is deemed to offend so many countries and people including economists, brokers, bankers, policy makers, and so on. Most recently, we cannot help mentioning the worst financial crisis in the US in 2007 – 2009 ever seen not only severely damaging the US economy itself but...

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Nội dung Text: United State Financial Crisis 2007 - 2008

Macroeconomic Assignment UNITED STATE FINANCIAL CRISIS 2007-2008 Group member Name Student ID 1. Pham Thanh Hai 0851050064 2. Nguyen Quynh Mai 0851050049 3. Nguyen Huong Thuy 0851050059 4. Dao Bich Ngoc 0851050051 5. Duong Thi Minh Thu 0851050057 6. Dang Hong Thai 0851050019 7. Dinh Thi Bich Phuong 0851050054 1
TABLE OF CONTENT PREFACE...................................................................................................................................3 CONTENT ..................................................................................................................................4 I. SIGNALS OF FINANCIAL CRISIS IN US ON THE US ECONOMY ................................4 II. IMPACTS OF HOUSING/CREDIT CRISIS IN US ON THE US ECONOMY ....................7 1. Effects on US Financial Institution ...........................................................................7 2. Effect on Money Supply ..........................................................................................10 3. US Trade Deficit ............................................................. Error! Bookmark not defined. 4. Impacts on US macro-economy .............................................................................11 5. Global economics effects .......................................................................................12 III. REASON FOR THE CRISIS ......................................................................................14 1. The imbalance of US economy ...............................................................................14 2. Loosened regulation ...............................................................................................17 IV. SOLUTIONS..............................................................................................................18 1. Emergency economic stabilization act of 2008 .....................................................18 2. Economic stimulus act of 2008...............................................................................20 3. The American Recovery and Reinvestment Act of 2009 (ARRA) .........................20 4. Act of Fed .................................................................................................................22 5. Development under the Acts: .................................................................................23 CONCLUSION ..........................................................................................................................25 REFERENCE............................................................................................................................25 2
PREFACE The global economy has been developing rapidly and gaining many achievements which have a lot of motivating influences on the wealth of many countries in the recent decades. However, there still remain a number of difficult problems that need proper solutions brought in by the governments. Financial crisis is not out of the case. For many years now, financial crisis is deemed to offend so many countries and people including economists, brokers, bankers, policy makers, and so on. Most recently, we cannot help mentioning the worst financial crisis in the US in 2007 – 2009 ever seen not only severely damaging the US economy itself but the global economy. The financial crisis in US was directly the main reason for the following Great Financial Crisis which proceeded globally in a very complicated way and caused the worldwide destruction to quite a few giant established economies such as United States, United Kingdom, EU and so on. Therefore, no matter what politics or wealth level it may has, every country has the common responsibility to prevent the “tsunami” from spreading and damaging without control especially the developed countries. However, it depends on the particular economic characteristics of each nation like integration priority, economic scale and regime to give their own policies. All things considered, we may reach an important conclusion that the focal point of all possible solutions is what addressed radically the financial hazards related to stock market and banking system. Thence, we are going to do a thorough research into the causes, progress and impacts of the crisis in respect of the macroeconomics as well as financial and banking terms which may bring about many insightful implications for Vietnam in practical policy implementation to survive the global crisis. 3
CONTENT I. SIGNALS OF FINANCIAL CRISIS IN US ON THE US ECONOMY The US financial crisis happened worse and worse each day, while the number of entrepreneurs which collapsed or were taken over increased continuously day by day. After the plan of $700-billion-rescue package was not approve by House of Representatives, Dow Jones Index fell down to 770 points or 6.9% - the biggest decreasing daily volume since the crisis arise. (From 16.8.2008 till 8.10.2008) nd th From 2 February 2007 to 24 July 2009, 92 banks declared their bankruptcy. nd th From 22 February 2008 to 29 March 2009, 34 banks declared that they were taken over. 4
worth Institutions (taken over) T ype of organization (USD, EUR vàGBP) Retailed bank and mortgage Northern Rock credit Bear Stearns, New York City investment bank $2.200.000.000 Catholic Building Society mutual fund to buy house £51.000.000 Countrywide Financial, Calabasas, Secondary mortgage credit $4.000.000.000 California Retailed bank and mortgage Alliance & Leicester £1.260.000.000 credit $896.800.000 Retailed bank Roskilde Bank (kr4,500,000,000) Fannie Mae và Freddie Mac Secondary mortgage credit Derbyshire Building Society Mutual fund to buy house £7.100.000.000 Cheshire Building Society Mutual fund to buy house £4.900.000.000 Merrill Lynch, New York City Investment bank $44.000.000.000 American International Group, New Insurance company $182.000.000.000 York City Lehman Brothers, New York City B Investment bank $1.300.000.000 5
HBOS General financial services $21.850.000.000 W ashington Mutual, Seattle, Credit fund $1.900.000.000 W ashington C Lehman Brothers Investment bank $2 Bradford & BingleyD General financial services £21.100.000.000 General financial services €11.200.000.000 Fortis Public finance and retailed Dexia bank W achovia, Charlotte, North Carolina Retailed and investment bank $15.000.000.000 Commercial bank Landsbanki Commercial bank Glitnir Commercial bank Kaupthing Bank BankWest (subsidiary of HBOS) Bank £1.200.000.000 Sovereign Bank, Wyomissing, Bank $1.900.000.000 Pennsylvania Barnsley Building Society Mutual fund to buy house £376.000.000 National City Bank, Cleveland, Ohio Bank $5.580.000.000 6
Commerce Bancorp, Cherry Hill, New Bank $8.500.000.000 Jersey Scarborough Building Society Mutual fund to buy house IndyMac Federal Bank Credit fund $13.900.000.000 Anglo Irish Bank Bank Investment bank Straumur Investment Bank Dunfermline Building Society Mutual fund to buy house Credit fund €9.000.000.000 Caja de Ahorros Castilla La Mancha II. IMPACTS OF HOUSING/CREDIT CRISIS IN US ON THE US ECONOMY In this part, we mention the effect on 5 aspects of the economy: US Financial Institution, Money Supply, Trade Deficit, National Wealth, and some economic indicators. 1. Effects on US Financial Institution Firstly, the crisis began to affect the financial sector in February 2007 7
(1) The chart above expresses the trend of changing leverage ratio or the ratio of debt over equity of 4 big investment banks in US. Though the value of this ratio is different through these 4 great banks, it is clear to point out that this ratio has trend of increasing strongly as times went by. Merrill Lynch is a typical example with the huge increase from ratio as about 20 in 2006 jumping to over 30 in 2007. So impressively, this bank jumped from just 15 up to over 30 after 4 years. In addition, as we can see from the chart, 4 of 5 banks had the ratios over 30 in 2007, compared with just 1 bank had this level of ratio in 2006 and all banks had the ratios as 20-25 in 3 previous years. This is the detailed data for the losses of many banks and financial institution. Company Business Type Loss (Billion USD) Citigroup bank $39.1 bln Merrill Lynch investment bank $29.1 bln Morgan Stanley investment bank $11.5 bln Bank of America bank $7.95 bln Bear Stearns investment bank $2.6 bln W ashington Mutual savings and loan $2.4 bln Lehman Brothers investment bank $3.93 bln JP Morgan Chase bank $5.5 bln Goldman Sachs investment bank $1.5 bln Freddie Mac mortgage GSE $4.3 bln W ells Fargo bank $2.9 bln Fannie Mae mortgage GSE $0.896 bln MBIA bond insurance $3.3 bln Ambac Financial Group bond insurance $3.5 bln American International Group insurance $11.1 bln Countrywide mortgage bank $4.0 bln 8
A series of financial institution have suffered from a huge loss. According to IMF, the total losses of all mortgage loan is about 495 billion USD. During 2007, at least 100 mortgage companies either shut down, suspended operations or were sold. More and more financial firms either merged, or .(3) announced that they were negotiating seeking merger partners During 2007, the crisis caused panic in financial markets. That encouraged investors to take their money out of risky mortgage bonds and shaky equities. During 2008, three of the largest U.S. investment banks either went bankrupt (Lehman Brothers) or were sold at fire sale prices to other banks (Bear Stearns and Merrill Lynch). These failures augmented the instability in the global financial system. As a result of bankruptcy in US, people worried and withdraw their money in the bank, making the situation worse. This is the imagine of people queuing at the front door of Northern Rock bank in England, one of the first victim of the crisis. People and investors are really afraid of a collapse of financial system. 9
2. Effect on Money Supply During late 2008, the most liquid measurement of the U.S. money supply (M1) increased significantly as the government intervened to inject funds into the system.The focus on managing the money supply has been de-emphasized in recent history as inflation has moderated in developed countries. Historically, a sudden increase in the money supply might result in an (3) increase in interest rates to ward off inflation or inflationary expectations. Should the U.S. government create large quantities of money to help it purchase toxic mortgage- backed securities and other poorly-performing assets from banks? There is risk of inflation and dollar devaluation relative to other countries. However, the dollar has strengthened as other countries have lowered their own interest rates during the crisis. This is because demand for a currency is typically proportional to interest rates; lowering interest rates lowers demand for a currency and thus it declines relative to other currencies. 10
During a January 2009 speech, Fed Chairman Ben Bernanke described the strategy of lending against various types of collateral as "Credit Easing" and explained the risks of inflation as follows: "Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve is effectively printing money, an action that will ultimately be inflationary. The Fed's lending activities have indeed resulted in a large increase in the excess reserves held by banks. Bank reserves, together with currency, make up the narrowest definition of money, the monetary base; as you would expect, this measure of money has risen significantly as the Fed's balance sheet has expanded. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base. At this point, with global economic activity weak and commodity prices at low levels, we see little risk of (3) inflation in the near term; indeed, we expect inflation to continue to moderate." 3. Impacts on US macro-economy Next, we mention the effect of financial crisis on some other economic indicators such as GDP and Unemployment rate. Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of approximately 6 percent in the fourth quarter of 2008 and first quarter of 2009, versus activity in the year-ago periods. The U.S. unemployment rate increased to 10.2% by October 2009, the highest rate since 1983 and roughly twice the pre-crisis rate. The average hours per work week declined to 33, the lowest level since the government began collecting the data in 1964. This is the chart showing changes in GDP and unemployment rate during the crisis and forecasting for the future in comparison with Canada. The figure is collected from the IMF website: 11
(6) You can see on the chart , f rom 2007 to 2009, the GDP growth rate dramatically fell. We just focus on the year 2007, 2008, 2009 and find that’s the very bad impacts. The unemployment rate, in contrast, rise to the number of 10.2 % in the late of 2009. US economy really seriously affected by the financial crisis. 4. Global economics effects Financial crisis generated in United State and quickly develop and spread to global economics shock. The result was in September 2008 the industrialized world had been undergoing a recession. This global recession has been taking place in an economic environment characterized by various imbalances and was sparked by the outbreak of the financial crisis of 2007–2010. This figure shows us the real GDP growth rate in 2009 for many country and area in the world. The GDP growth rate of US is from -4% to -2 %. Many area in the world have the GDP growth rate is negative especially the North Asia. This indicated that the world is experiencing a recession. 12
The financial crisis has been linked to reckless and unsustainable lending practices compounded by government intervention and the growing trend of securitization of real estate mortgages in the United States. The US mortgage-backed securities, which had risks that were hard to assess, were marketed around the world. The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and over-inflated asset prices. With loan losses mounting and the fall of Lehman Brothers on September 15, 2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined many large and well established investment and commercial banks in the United States and Europe suffered huge losses and even faced bankruptcy, resulting in massive public financial assistance. A global recession has resulted in a sharp drop in international trade, rising unemployment and slumping commodity prices. In December 2008, the National Bureau of Economic Research (NBER) declared that the United States had been in recession since December 2007. Several economists have predicted that recovery may not appear until 2011 and that the recession will be the worst since the Great Depression of the 1930s. 13
III. REASON FOR THE CRISIS The imbalance of US economy 1. 1.1 Consumption-oriented policy W hile almost all countries in the world stimulate their economies through investment and export, the US chose its own way to maintain the growth rate by promoting and encouraging internal consumption. In these years the public consumption, which has always taken up the increasingly high portion in US GDP, contributed up to 70% of US GDP. This policy at first seemed to be rather positive when consumers have high belief in the economy. However, this policy was creating a big hole, which made the economy become imbalanced. The US gradually had the tendency to be over-optimistic and over-encouraged by the looseness of credit institutions. This created the increasingly huge trade deficit and made the economy rather vulnerable. In order to sponsor for such huge trade deficit, the US were willing to borrow from outsides by issuing bonds all over the world. In the last 5 years, the US average extra loan was $2 bill. When the trade deficit increased steadily in many years, Fed would have to increase money supply to settle the maturity debts, which would make the USD depreciate, public belief in depreciate also and consumers, therefore, would cut down on their expenditures. On that condition, the US would lose its only impetus for economic growth and dive into total recession. 1.2 Housing market boom Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years before the crisis, fueling a housing market boom and encouraging debt-financed consumption. While housing prices were increasing, consumers were saving less and both borrowing and spending more. This credit and house price explosion led to a building boom and then to a surplus of unsold homes, which caused U.S. housing prices to peak and begin declining in mid-2006. Easy credit, and a belief that house prices would continue to appreciate, had encouraged many subprime borrowers to obtain adjustable-rate mortgages. These mortgages appealed to borrowers with a below market interest rate for some predetermined period, followed by market interest rates for the remainder of the mortgage's term. Borrowers who could not make the higher 14
payments once the initial grace period ended would try to refinance their mortgages. Refinancing became more difficult, once house prices began to decline in many parts of the USA. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default. As more borrowers stop paying their mortgage payments, foreclosures and the supply of homes for sale increase. This places downward pressure on housing prices, which further lowers homeowners' equity. The decline in mortgage payments also reduces the value of mortgage- backed securities, which erodes the net worth and financial health of banks. This vicious cycle is at the heart of the crisis. 1.3 High-risk mortgage loans and lending/borrowing practices In the years before the crisis, the behavior of lenders changed dramatically. Lenders offered more and more loans to higher-risk borrowers, including illegal immigrants. In addition to considering higher-risk borrowers, lenders have offered increasingly risky loan options and borrowing incentives. The mortgage qualification guidelines began to change. At first, the stated income, verified assets (SIVA) loans came out. Proof of income was no longer needed. Borrowers just needed to "state" it and show that they had money in the bank. Then, the no income, verified assets (NIVA) loans came out. The lender no longer required proof of employment. Borrowers just needed to show proof of money in their bank accounts. The qualification guidelines kept getting looser in order to produce more mortgages and more securities. This led to the creation of NINA. NINA is an abbreviation of No Income No Assets. Basically, NINA loans are official loan products and let you borrow money without having to prove or even state any owned assets. All that was required for a mortgage was a credit score. 1.4 Securitization practices The traditional mortgage model involved a bank originating a loan to the borrower/homeowner and retaining the credit (default) risk. With the advent of securitization, the traditional model has given way to the "originate to distribute" model, in which banks essentially sell the mortgages and distribute credit risk to investors through mortgage-backed securities. Securitization meant that 15
those issuing mortgages were no longer required to hold them to maturity. By selling the mortgages to investors, the originating banks restocked their funds, enabling them to issue more loans and generating transaction fees. This created a moral hazard in which an increased focus on processing mortgage transactions was incentivized but ensuring their credit quality was not. 1.5 US balance of payments In 2005, Ben Bernanke addressed the implications of the USA's high and rising current account deficit, resulting from USA investment exceeding its savings, or imports exceeding exports. The US attracted a great deal of foreign investment, mainly from the emerging economies in Asia and oil- exporting nations. The balance of payments identity requires that a country (such as the USA) running a current account deficit also have a capital account (investment) surplus of the same amount. Foreign investors had these funds to lend, either because they had very high personal savings rates (as high as 40% in China), or because of high oil prices. Bernanke referred to this as a "saving glut" that may have pushed capital into the USA, a view differing from that of some other economists, who view such capital as having been pulled into the USA by its high consumption levels. In other words, a nation cannot consume more than its income unless it sells assets to foreigners, or foreigners are willing to lend to it. Alternatively, if a nation wishes to increase domestic investment in plant and equipment, it will also increase its level of imports to maintain balance if it has a floating exchange rate. Regardless of the push or pull view, a "flood" of funds (capital or liquidity) reached the USA financial markets. Foreign governments supplied funds by purchasing USA Treasury bonds and thus avoided much of the direct impact of the crisis. USA households, on the other hand, used funds borrowed from foreigners to finance consumption or to bid up the prices of housing and financial assets. Financial institutions invested foreign funds in mortgage-backed securities. USA housing and financial assets dramatically declined in value after the housing bubble burst. 16
Loosened regulation 2. On the other hand, IMF did not agree with these above reasons. In an announcement on 6/3/2009, IMF believed that the main reason for the US recession is the undisciplined situation of financial system. IMF Chief Economist said the imbalance in the US economy is only an indirect reason 2.1 Shadow banking system The US authority set the door open for every new financial institution but did not have any control at all, not even officially collected statistics about them. The supervising financial system is loose, powerless and limited. Shadow banking system, a very complicated network, which includes investment banks, speculative funds, real estate loan organizations… is not supervised as properly as commercial banks. According to IMF, the reason for this situation is the underestimate of the importance of these organizations. They gradually became larger and larger and eventually played an indispensable role in financial system. At the end of 2007, the assets of bank-like institutions that were out of the control of US regulations were about 10.000 billion USD, the same as the assets of controlled commercial banks. 2.2 Risky investments Another indicator of the weak supervision is to make opportunities for risky investments. In other words, the US authority allowed investors to take advantages of gaps and make the public have a blind confidence in them. For example, the US authority allowed insurance company to insure things that are even uninsurable such as the value of stocks. Normally, insured activities such as health or accident are based on random probability and statistics but people can guess life expectancy, disease ratio or accident. However, stock value insurance, especially stocks without security, is absolutely based on the belief that market should never go down. As the result, when stock market goes down, these companies go bankruptcy because they cannot cover the amount of money lost by the loser. Speculative investments are completely allowed. Naked shorting is a symbolic example. This is an activity that financial investors push the stock price down to get profit. They sell stocks at high price and buy stocks at low price. 17
2.3 Pipe-laying The US authority used two companies (Fannie Mae and Freddie Mac) to carry out demagogy. Before 1968, these two companies had a duty of insuring for people who had low salaries to encourage banks to lend people money to buy houses. Normally, people can buy houses only if they have the amount of capital greater than 20% of house price. In 1968, two companies became joint stock company under the House of Representative’s authorization. However, they are not taxed because they are patronized by the government. In 1992, the 102nd Congress under the George H. W. Bush administration weakened regulation of Fannie Mae and Freddie Mac with the goal of making available more money for the issuance of home loans. Congress also wanted to free up money for Fannie Mae and Freddie Mac to buy mortgage loans and specified that the pair would be required to keep a much smaller share of their funds on hand than other financial institutions. Whereas banks that held $100 could spend $90 buying mortgage loans, Fannie Mae and Freddie Mac could spend $97.50 buying loans. Finally, Congress ordered that the companies be required to keep more capital as a cushion against losses if they invested in riskier securities. In 1999, the US House of representatives even crossed out the conditions to buy house: people did not have to pay in full within two years and the interest rate was lower than one in the market. The aim of these actions is to court the belief of the poor for the election. IV. SOLUTIONS The macroeconomic policies and financial rescue plans were issued by the government of Bush President very early. Before the $700 billion programme, the Federal Reserve (FED) injected hundreds of billions of dollars to protect many huge corporations from bankruptcy. “Wall Street” Rescue Plans were continuously issued. However, the effectiveness has been still inadequate. 1. Emergency economic stabilization act of 2008 Both Treasury Secretary Henry Paulson and FED chairman Ben Bernanke stated that this act was necessary for the American economic crisis. This not only would help to stabilize the economy, improve liquidity but also increase investor’s confidence and make an impact on economy and 18
GDP. The financial solution of this package is to create the T roubled Asset Relief Program (TARP) Troubled Asset Relief Program. The Secretary of the Treasury established the Troubles Assets Relief Programme to purchase troubled assets from financial institutions. The Office of Financial Stability is created within the Treasury Department, consulting with the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Secretary of Housing and Urban Development.. when running the program. According to the programme, $700 billion would be injected to the financial market.The Treasury Secretary had immediate access to the first $250 billion. Following that, an additional $100 billion can be authorized by the President 1.1 Purchase troubled assets and stock from financial institutions According to the original plan, $350 billion of this fund (taxpayer money raised through treasury bonds) would be used to purchase bad debt from financial institutions in the form of mortgages and mortgage-backed securities (MBSs). However, with the amended plan, the Treasury decided to purchase non-voting stock and commercial paper of these financial group also to help them deal with the lost during the period of financial crisis and be able to lend again. In a report dated February 6, 2009: The COP found the Treasury paid $254 billion for assets in this programme. 1.2 Guarantee on bank deposits This fund was also used for guarantee on bank deposits from $100,000 to $250,000 to make the lending. This was operated by Federal Deposit Insurance Corporation ( FDIC). The purpose of this was to increase the belief of lender in the banking systems and avoid their drawing back. 1.3 Insurance policies on bad debts The bill also authorizes the OFS to issue insurance policies on bad debts, in lieu of buying debt outright. 19
1.4 Executive pay limits Pay for executives of the companies participating the programme- receiving federal bailout money (The Treasury purchases assets directly from these companies) will be capped at an amount under a revised financial compensation plan. As of February 9, 2009, $388 billion had been allotted, and $296 billion spent, according to the Committee for a Responsible Federal Budget. Economic stimulus act of 2008 2. This was an act of Congress enacted in February 13, 2008, providing for several kinds of economic stimulus intended to boost the United States economy in 2008 and to avert a recession, or ameliorate economic condition. The law provides for tax rebates to low- and middle-income U.S. taxpayers with the amount not less than $300, tax incentives to stimulate business investment, and an increase in the limits imposed on mortgages eligible for purchase by government-sponsored enterprises (e.g., Fannie Mae and Freddie Mac). The total cost of this bill was projected at $152 billion for 2008. 3. The American Recovery and Reinvestment Act of 2009 (ARRA) In late 2008, President Obama stated that the rescue programme did not have the expected results. He said that it’s a fault to only inject money to big financial institutions with purpose of stablize financial markets. The American Recovery and Reinvestment Act of 2009 (ARRA) (Public Law 111-5) and commonly referred to as the Stimulus or The Recovery Act, is an economic stimulus package enacted by the 111th United States Congress in February 17, 2009. This Statement of Purpose included the following: To preserve and create jobs and promote economic recovery  To provide investments needed to increase economic efficiency by spurring technological  advances in science and health. 20